Can Bitcoin Solve Wall Street's Soft Dollar Problem?

Instead of CSA credits, Bitcoin provides a safe and transferable currency for soft dollars. Could it work?

Unbundling held so much promise for Commission Sharing Arrangements (CSAs). Unbundling was supposed to let asset managers apply commission credits earned through execution services from one broker to another broker's service, such as for research. It all seemed like a great idea and asset managers traded frequently with Lehman Brothers and Bear Stearns. But, when those firms collapsed, the commission credits disappeared, as they were not viewed as real currency.

The Hedge Funds or large institutions that I work with all want the same thing -- one aggregated balance to which they can apply their earned commission credits across different services, regardless of where they executed their securities transactions.

For a long time I thought the best way to achieve this was through a single CSA system with a trusted clearing company that could be used as an aggregator. As long as the asset manager felt confident that the clearing broker was solid and could not collapse, it would be easy to build a single account where research and services could be paid. But for now, asset managers spread their commission credits around, constantly assessing where they think there is less risk and trading off between the cost of execution services and where they can get the the most benefits.

Enter Bitcoin
But there is another way. What if the asset manager gets immediate access to their commission credit through Bitcoin: the peer-to-peer (P2P) digital currency?

Here's how it could work. The asset manager trades just as usual, instructing the broker to unbundle execution services from research and related services. Once the trade is done, a commission credit is generated and sent back to the asset manager as a Bitcoin. The broker can provide a wrapper around the BitCoin to track the use of the currency for only approved services.

The asset managers are happy because they can freely aggregate all of their Bitcoins from the many brokers they use and apply them to research and services that they are allowed to buy. They don't have to worry that the broker goes out of business.

The brokers are happy because they can track how the Bitcoins are being used and the administrative processing shifts to the buy side. The broker is still regulated, but the burden of processing checks and invoices disappears. Now we can let the best research win.

FIX And Bitcoin?
Taking it one more step further, the actual Bitcoin can come directly through a trade confirmation message itself using the FIX protocol. This is the "killer app." Now, rather than relying on rate calculations and detailed accounting, the commission credits are an intrinsic part of the trade itself. In the same way that gold holds intrinsic value, so too can the actual trade confirmations. As we all know, every asset manager can already process FIX, so integrating this new information would be simple work.

As long as there is faith that Bitcoin (or an analogous "Commission Credit Coin") is a solid currency, as there appears to be at least among the hedge fund community, then this could lead to tremendous progress in using CSAs for everyone.

What do you think? Will Bitcoin work as a possible alternative to funding and keeping track of CSAs?

George Kledaras is the founder and Chairman of FIX Flyer, a financial technology company in New York City. He is also the author of numerous articles about the FIX protocol and electronic trading standards, and a frequent speaker on the major technology issues of our ... View Full Bio

At the risk of defending soft dollars, CSAs are a cleaned up version and the payment process and administrative overhead is still a chore for brokers and the buy side who must log onto all the different broker web sites to allocate their trading credits to pay for research. I like your idea for using Bitcoin as a new currency, but the industry would have to pick a uber-depository to become the overseer. The buy side would need to have an RFP inviting various entities to participate. If Bitcoin doesn't pan out, something else could emerge, perhaps FIXcoin.

The SEC is satisfied with the way this regulation is working, that's why it is not a hot issue.

There is legitimate use of commission sharing as long as the research and services are real and offer competitive advantage for both. If not, it will show up in higher fees on the asset management side or higher expenses on the broker side, or both, and that means the investor will find a new place to park their capital. In an efficient, transparent, information industry there will be no where to hide.

It's never been better for investors to get more disclosure around fees. If you don't think your fund is competitive, then go to a passive index or ETF with low expenses. Brokers are making fees and invoices paid to vendors available for their institutional clients online. Next, we'll see people tracking the expense of research and services tied to investment performance.

It seems that the SEC has had bigger fish to fry lately, and soft dollars seems to be such a back burner issue today. Bitcoin would be interesting, but that means firms will have to work together on this. (good luck). Also, Bitcoin is by no means a proven, and stable, entity at this point.

And, as Brooke notes, are soft dollars legitimate credits, or are they just kickbacks?

The real problem with soft dollar brokerage is the lack of transparency, disclosure, and accountability. CSA's do nothing to change that, in fact CSA's merely put one broker in the position of managing the commission credits accumulated through that broker's trading.

In a SEC Sunshine Meeting July 12, 2006 the SEC commissioners stated that they would soon take up the issue of transparency and disclosure for ALL soft dollar brokerage arrangements. Subsequently, I wrote to the SEC several times asking about the status of that "second wing" of regulation. I never received a reply from the SEC about the status of deliberations, or regulations, relating to transparency and disclosure of ALL soft dollar brokerage commission arrangements.

Investment advisors and full-service brokerage firms using bundled undisclosed soft dollar brokerage commission arrangements have the potential to create conflicts of interest. And, such arrangements do nothing to aid the public in determining if client commissions spent on research and advice actually benefit the advisors' performance [such arrangements don't allow cost benefit analysis].

Before you solve the "soft dollar problem" you have to convince me that the problem with soft dollars is not that they are bribes, kickbacks, and ways of making clients pay for things managers should pay for themselves.